Bullish or bearish, technical indicators have some serious, deep-rooted flaws.
Recently, some technical indicators have flashed bullish signals. One in particular seems to have grabbed attention—the golden cross, viewed by technical analysis fans as a positive sign. But not all are on board, warning the supposedly bullish sign may not depict the future well this time.
The kerfuffle over how golden the golden cross is or isn’t strikes us as bizarre. When technical indicators trip bearish, it’s generally pretty darn difficult to find a skeptical analysis (again, among those predisposed to technical analysis) noting the sign isn’t necessarily indicative of what lies ahead. But today, a bullish indicator is just flatly dismissed. So we wonder: Are only bearish signals, like the often-seen-yet-rarely-accurate Hindenburg Omen or Death Cross, to be believed? Are signals with less ominous-sounding names somehow less reliable? Or is it just the interpreter looking at the same information, then applying how he or she feels at that moment? (An attempt to rationalize gut feelings.)
The reality is technical indicators aren’t reliable predictive tools. Consider: The bullish-when-some-seemingly-want-it-to-be golden cross is merely a chart pattern in which stocks’ 50-day moving average breaks above the 200-day moving average. Some strategists speculate this signifies a trend change—implying positive future movement. But before nodding along, consider it’s all a reference to the past, often indicating stocks have already moved higher.
And that seems at work here. In the recent sightings, folks are seemingly noticing the S&P’s 200-day moving average is flat to down, while the 50-day moving average is up. In other words, there was a correction in the summer and a rally in Q4 2011. We’re betting if you’re reading this, you already knew that—making the flip-flopping of moving averages seem less important harbinger and more old news.
Here’s a point many investors have struggled to grasp since the ticker tape’s advent: The print you just saw has little to no bearing on what follows. That’s difficult for many to accept, seemingly because humans are conditioned to find and follow patterns. For example, if our stone-age ancestors successfully found, hunted and killed three tasty prehistoric prey in one location, chances are they’d return. While this logic may yield success in a hunter-gatherer society, it has little application to non-serially correlated markets, where price movements can (and frequently do) shift on a dime. The decision to purchase a stock should be about the future, not one rooted in the past—a fundamental problem most technical analysis tools have at their core. The thought one graphical depiction of the past can capture all the myriad inputs into determining future market direction is romantic, but fantastical.
But that’s not all! Another confusing aspect of many technical indicators is their seemingly arbitrary construction. For example, here are some questions regarding the golden cross: Why was the 200-day moving average selected? Why not 211? Or 196? (Because it’s a round number isn’t a great, fact-driven answer.) And why the average and not the median? Most of these indicators seem a perfectly random selection of timeframe, construction and depiction. Then they’re left to user interpretation. And all this, again, is a reflection of the past—which (stop us if you’ve read this before) isn’t indicative of future price movement.
So sure, we wouldn’t recommend building a 2012 forecast based on the golden cross. But we’d suggest the issue here isn’t limited to the golden cross, and it isn’t unique this time, applying equally to death crosses, Hindenburg Omens, Ichimoku Clouds, Doji Candlesticks and everything in between, at virtually any time.
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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.